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Bank of Canada Sees No Housing Bubble Yet

Printed in Financial Post January 12, 2010.

OTTAWA -- The Bank of Canada Monday dismissed talk of a housing bubble in Canada as "premature," warning that calls for higher interest rates now in an effort to temper real-estate markets would be akin to "dousing" the economic recovery with cold water.

It delivered this message through a speech in Edmonton, and marked the first time the central bank tried to address directly myriad concerns that the country's real-estate market is appreciating too quickly, too soon.

"Recent house price increases do not appear to be out of line with the underlying supply-demand fundamentals," David Wolf, an advisor to the governor, Mark Carney, said in prepared remarks.

Data indicate existing-home prices have climbed 21% from a year ago while sales volume has surged 41%, prompting observers to indicate a housing bubble was underway due to record-low interest rates. New figures released Monday suggest housing starts rose 5.9% to a seasonally adjusted rate of 174,500 units in December, easily beating economists' average forecast of 160,000.

Mr. Wolf said housing bubbles, such as the one the United States experienced last decade, are usually fuelled by credit expansion, as borrowers and lenders "take false comfort from exaggerated house prices."

The current rally, during which existing-home sales have climbed more than 40% on a year-over-year basis as of November and prices have surged nearly 20%, is largely due to what Mr. Wolf described as "temporary factors," such as low interest rates and pent-up demand. Further, some buying has been "pulled forward," as people realize this is a once-in-a-lifetime opportunity to acquire property with historically cheap financing.

These factors cannot continue to drive home sales and prices, Mr. Wolf said."Thus, we see the housing market as requiring vigilance, but not alarm," said Mr. Wolf, who delivered the speech on behalf of deputy governor Timothy Lane.

He said the central bank is monitoring housing closely, and warned of the implications of using monetary policy to cool the market.

"If the bank were to raise interest rates to cool the housing market now - when inflation is expected to remain below target for the next year and a half - we would, in essence, be dousing the entire Canadian economy with cold water, just as it emerges from recession. As a result, it would take longer for economic growth to return to potential and for inflation to get back to target," he said.

The Bank of Canada has pledged to keep its benchmark rate at a record low 0.25% until July in an effort to foster growth and bring inflation to the central bank's preferred 2% target (which is expected in the second half of 2011).

Instead, regulatory changes - from changes to banks' capital requirements to the terms and conditions for mandatory mortgage insurance - are the preferred route to deal with housing-market excess, should concerns mount. This largely repeats the view forwarded last week by Ben Bernanke, chairman of the U.S. Federal Reserve.

Jim Flaherty, the Minister of Finance, has indicated he is concerned about the record levels of household debt and could introduce regulatory changes to address it, such as more stringent requirements to get mortgage insurance, which is a key condition required before banks agree to extend financing for a home purchase. Analysts say such a change could be included in the next federal budget, to be tabled in early March.

Economists at Scotia Capital said in a note the speech suggested the central bank was becoming "uncomfortable" with the "lightning-rod bubble talk" in the marketplace.

Nonetheless, the central bank "flagged the temporary nature of many of the factors driving recent strengths," they said.

Michael Gregory, senior economist at BMO Capital Markets, said mortgage growth has been rapid - around 7% on a year-over-year and three-month basis - but remains in single-digit territory and below historical peaks. Still, "a few more months of rapid credit growth and the [central bank's] conclusion may be very different."

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